Guest Post: The Fiscal Cliff And The Grand Bargain

Tyler Durden's picture


Submitted by Charles Hugh-Smith of OfTwoMinds blog,

The Grand Bargain is unraveling, and a new arrangement will take the place of the Status Quo--whether we like it or not.

Correspondent Arnold suggested that I address the fiscal cliff, so here goes.
The first step is to set aside ideological blinders and confirmation bias, i.e. only looking for data that supports our current beliefs.
The second step is to look at the foundation of everything: household income.Household income is the foundation of taxes paid, consumption (spending) and savings/investment. If household income is declining, that means the pie of money that can be divided up into taxes paid, consumption and investment is shrinking.
If taxes go up, there is less pie left for spending or investment. And since the economy ultimately depends on private-sector spending and investment, then reducing those to fund government spending means there will be less private spending and investment.
If the government spent the taxes on investments that yielded a higher return than private investments, higher taxes would not devastate the economy. But the problem is that there are no feedbacks on government spending that favor efficiency or high yields.
Government spending decisions are made solely on the basis of constituency pain:the constituencies that create the most political pain for politicos and Upper-Caste government bureaucrats get funding. Efficiency and high-yielding investments are not in the political equation at all; there is no feedback in monopolies except those that favor expansion of budgets and constituencies.
Let's look at a chart of household income from Median Household Incomes: The "Real" Story (Doug Short)Household income has been negative since 2000 except for two brief spikes:
Here is another chart depicting the huge gap between nominal income and real income:while nominal income rose a seemingly healthy 25% since 2000, real income has declined almost 10%.
Median income doesn't tell us who is getting most of the income, so let's look at this: All the increases in income since 1970 accrued to the top 10%.
But we have to remember that median income includes all income, including the wealthy. Real income has declined by 8%-9%. The pie is smaller, period.
Some of that is due to a declining full-time workforce, which has dropped to 115 million workers:
Now let's look at the size of government spending and taxation. In terms of the overall economy (GDP), government spending's share of the economy has been rising for decades. The Internet and housing bubbles briefly "grew" the economy faster than government spending, but once these one-off expansions faded, government spending quickly returned to its trendline (ever higher).
Federal spending rose exponentially until it exceeded the carrying capacity of the economy. For context, recall that Social Security costs $817 billion, Medicare and Medicaid costs total about $800 billion annually, and the Pentagon/National Security budget is around $690 billion. Add in interest on the ballooning national debt, and the vast majority of the Federal budget goes to these four. You could eliminate all other Federal spending and these four consume all the tax revenues and then some.
Tax receipts, meanwhile, topped out at $2.4 trillion, leaving a structural gap of $1.3 trillion.
OK, so now we see why government spending can't keep following an exponential path higher: households are earning less income.
Next up: the welfare/cartel State. Some welfare flows directly to individuals ("transfer payments") and some flows to cartels: defense, sickcare, the education cartels, etc.
The problem here is the number of citizens who are dependent on government transfers and spending now exceeds the number of full-time workers. Recall (see chart above) there are 115 million full-time workers in the U.S.
Of the roughly 150 million workers in the U.S., 38 million earn less than $10,000 per year, 50 million earn less that $15,000 a year and 61 million earn less than $20,000 annually. All these numbers are drawn directly from Social Security Administration payroll data.
100 million wage earners, or 2/3 the entire workforce, earn less than $40,000 per year.
In practical terms, only the 115 million full-time workers pay significant taxes, and of those, The top 25% (those earning more than $66,193) paid 87% of the taxes. The bottom 50% of taxpayers, roughly 70 million people, earned 13% of the income and paid 2% of the income taxes collected.
(The top 1% of taxpayers reported almost 17% of all taxable income and paid 37% of all income taxes. The top 5% reported 32% of all income and paid 59% of the taxes, and the top 10% earned 43% of the income and paid 70% of the taxes. Where Do You Rank as a Taxpayer?)
There are roughly 127 million people dependent on government transfers: 61 million recipients of Social Security and Medicare (That Which is Unsustainable Will Go Away: Medicare May 16, 2012) (or Medicaid for the 11 million people drawing lifetime SSI Social Security disability) and 66 million people receiving welfare (SNAP food stamps, housing credits, Medicaid, etc.): When Work Is Punished: The Tragedy Of America's Welfare State(Zero Hedge)
That means there are 1.1 government dependents for every full-time worker in the U.S. Please read the linked stories above if you believe this is sustainable.
In my analysis, there has been a Grand Bargain reached by the 3.5 classes in the U.S. The Three-and-a-Half Class Society (October 22, 2012)
The top 1/2th of 1% owns most of the productive assets of the nation and most of its machinery of governance (this is the "half class"). Most of the income not siphoned off by this "we own the important stuff" class goes to the next 19.5% who pay most of the Federal taxes (class #1).
Class #2 is the dwindling "middle class" (also known as the working poor) which receives no government transfers and lives off earned income. This is perhaps 30% of the households.
Class #3 is the lower 50% who depend on transfers, subsidies, etc. because they are retired, don't make enough at their jobs to support their families or are disabled (legitimately or otherwise).
The Grand Bargain was this: we at the top will pay significant taxes as long as we get to control the levers of financial and political power. We in the top 19% will pay much of the taxes as long as we and our children can continue to live well and accumulate wealth. We in the "middle class" will continue to work hard as long as we have hope of bettering our lifestyle and the lives of our children. We in the bottom 50% and retirees agree not to threaten the top .5%'s power and the wealth of the top 19% as long as we can get by on our government transfers.
This Grand Bargain is now fraying as the promises made to everyone cannot possibly be met. Claims on welfare and disability programs are skyrocketing at the same time that the demographics of an aging populace are causing 10,000 people a day to enter Social Security and Medicare, the two costliest government programs. The triple-whammy is the upper-middle class that pays most of the taxes has been slammed with lower income and a devastating drop in their net worth.
That which is unsustainable will be replaced by another more sustainable arrangement. Everyone who slips off their ideological/self-interest blinders knows the Status Quo is unsustainable, and so everyone in the 3.5 classes is shifting nervously: will I get taxed to the point of "uncle" or will my bennies get slashed?
By heavily taxing earned income, the system extracts the highest taxes from the most productive citizens, leaving the less-productive with essentially no income taxes and the super-wealthy with the huge tax break offered to capital gains and other unearned income.

In essence, this is a vote-buying scheme by the Status Quo: the top .5% control the policies of the State in alliance with the State's own Elites, and together they buy the complicity of the bottom 50% to passively accept their dominance.

In other words, the bottom 50% pay relatively modest taxes or are recipients of Central State aid and the top .5% who "own" the political process limit their taxes by favoring unearned income (what they collect from sales of securities, stock options, rents, etc.). Thus the productive quintile (top wage earners) pay the highest tax rates and most of the taxes.
It's a partnership of "Tyranny of the Majority" and "entrenched incumbents Elites."If the political Status Quo alienates the majority by making them pay more taxes, they risk losing power in the next election. If they alienate the top .5% who fund their multi-million-dollar campaigns, then they will also lose power. So they heap the tax burden on what remains of the upper-middle class.
When that 20% rebels, falters or opts out, the system collapses for want of tax revenues. Not coincidentally, that happens to fit the Pareto Distribution: the 20% "vital few" exert outsized influence on the 80%.
The Grand Bargain is unraveling, and a new arrangement will take the place of the Status Quo--whether we like it or not.

My new book Why Things Are Falling Apart and What We Can Do About It is now available in print and Kindle editions--10% to 20% discounts.

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Wed, 11/28/2012 - 14:28 | 3017987 Clowns on Acid
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Whats the problem here? When the 20% stop producing, the Fed will just print more fiat and everything will be alright.

Just like Argentina has done. What's the problem?

Wed, 11/28/2012 - 14:35 | 3017999 HappyCamper
HappyCamper's picture

It’s a Mexican standoff and the hands holding the guns are starting to shake. Just wait until the next Black Swan, bitchez!

Wed, 11/28/2012 - 14:40 | 3018007 MillionDollarBonus_
MillionDollarBonus_'s picture
Libertarians are far too simplistic. Theories like the 'non-aggression principle' may work in a libertarian utopian fantasy world, but the real world isn't that simple. Only politicians can solve complex real-world problems like contract enforcement and poverty reduction. Governments have long and successful track records of enforcing contracts, securing justice and promoting upward mobility for the poor, so libertarians are quite frankly idiots for even questioning the idea of the state. The welfare state has a track record of permanently reducing poverty, just as progressive scholars predicted. I'm not going to go into detail about examples here, but there are plenty out there. The free market on the other hand has played little or no role in poverty reduction. To summarize: politicians NEED to have the exclusive right to initiate the use of force. There is simply no way around this. I have thought very, very hard about this issue, and I simply cannot think of an alternative. I'm no longer willing to consider alternatives either. I've thought about this problem long enough and it has now become tiresome.
Wed, 11/28/2012 - 14:41 | 3018014 Bay of Pigs
Bay of Pigs's picture

"I'm no longer willing to consider alternatives either"

HAHAHA...nice one MDB.

Wed, 11/28/2012 - 14:43 | 3018020 El Viejo
El Viejo's picture

What about Govt contractors??

I'm told that they are not accounted for.

Wed, 11/28/2012 - 15:15 | 3018143 hedgeless_horseman
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Government spending decisions are made solely on the basis of constituency painpay: the constituencies that create the most political painpay for politicos and Upper-Caste government bureaucrats get funding.

Why not a 50% tax on bribes campaign contributions?

Wed, 11/28/2012 - 15:30 | 3018199 El Viejo
El Viejo's picture

When politicians retire they get to keep their campaign contribution kitty. (talk about unearned income!) Why not put that back into a general election fund for that party??

Wed, 11/28/2012 - 15:50 | 3018248 economics9698
economics9698's picture

"We at the top will pay significant taxes as long as we get to control the levers of financial and political power." 

Dude the top 0.01% has been running the show since 1913.  The bargain is about $10 trillion and a few decades late.

Sorry bro, you should read ZH once in awhile instead of getting a guest post.


MDB  "The welfare state has a track record of permanently reducing poverty, just as progressive scholars predicted."

Yea bro I see that.  /sarc


Wed, 11/28/2012 - 17:59 | 3018550 socalbeach
socalbeach's picture

While you're at it, maybe you can explain these 2 statements from the article to me,

"If household income is declining, that means the pie of money that can be divided up into taxes paid, consumption and investment is shrinking."

Investment includes business investment obviously. And business investment could increase even with decreasing real household income, for example, by increased government spending or increased profits.  Also,

"OK, so now we see why government spending can't keep following an exponential path higher: households are earning less income."

ignores Fed money printing and business income, and it's mixing real household income with nominal government spending.

Wed, 11/28/2012 - 14:43 | 3018021 macholatte
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By the skillful and sustained use of propaganda, one can make a people see even heaven as hell or an extremely wretched life as paradise.
Adolf Hitler

Wed, 11/28/2012 - 14:46 | 3018027 HappyCamper
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"I have thought very, very hard about this issue, and I simply cannot think of an alternative. " - MDB

Garbage in = Garbage out.

Wed, 11/28/2012 - 14:47 | 3018029 vast-dom
vast-dom's picture

your Swiftian polemical posts never cease to amaze MDB. bravo!

Wed, 11/28/2012 - 14:49 | 3018034 LawsofPhysics
LawsofPhysics's picture

What MDB is willing to "consider" or "think" is irrelevant to the laws of Nature and Physics.  People know the real value of their labor and they all still like to eat.  Go ahead, steal the value of anyone's labor, just be prepared for consequences you dumb fuck. 

Wed, 11/28/2012 - 14:59 | 3018070 Overflow-admin
Overflow-admin's picture

"The welfare state has a track record of permanently reducing poverty" -> hem, no comment ^^


Talking about progressive teachers, didn't they explain you anything like what means "separation of powers" and especially "consider alternatives"? Fool.

Wed, 11/28/2012 - 15:01 | 3018082 ebworthen
ebworthen's picture

MDBonus - When I read this sentence I knew your post was ingenious satire:

"Only politicians can solve complex real-world problems like contract enforcement and poverty reduction."

Wed, 11/28/2012 - 15:12 | 3018142 Vince Clortho
Vince Clortho's picture

It is heart warming to see there are some out there that appreciate the wisdom and service of our politicians who sacrifice so much, always trying to do what is best for the people they serve.

Wed, 11/28/2012 - 15:12 | 3018146 WeekendAtBernankes
WeekendAtBernankes's picture

The welfare state has a track record of permanently reducing poverty...



Wed, 11/28/2012 - 17:08 | 3018483 Qualitative Tig...
Qualitative Tightening's picture

"politicians NEED to have the exclusive right to initiate the use of force."


And next these politicians will simply use their 'exclusive' force to declare all private property common property and transition us to a communist state, with your all powerful, all knowing politicians in charge. We all know how that scenario ends...


Wed, 11/28/2012 - 21:03 | 3019072 StychoKiller
StychoKiller's picture

[quote] The welfare state has a track record of permanently reducing poverty, just as progressive scholars predicted. [/quote]

This planet that you're from, does it have unicorns?

Sun, 12/09/2012 - 14:57 | 3047141 MeelionDollerBogus
MeelionDollerBogus's picture


Wed, 11/28/2012 - 14:35 | 3018000 SilverTree
SilverTree's picture

OT Bitchez!

BREAKING: North Lebanon border town under Syrian shelling! Israeli Forces Cross into Lebanon! Lebanese Army on Full Alert

Wed, 11/28/2012 - 15:18 | 3018167 Spastica Rex
Spastica Rex's picture

11 paratroopers. Oh, come on.


Wed, 11/28/2012 - 14:37 | 3018006 zuuma
zuuma's picture

I see no problem here!

I'm sort of at the "I don't care, anymore" point.  I just want the other shoe to drop.

If Zero want's to crash the economy, then DO IT!   Then he can blame the GOP & start minting zinc coins with his face on them.

Eventually, I'll be able to paddle my canoe around the rocks again - like always.

It's been so dark on the river for so long.


Wed, 11/28/2012 - 17:55 | 3018617 DosZap
DosZap's picture

If Zero want's to crash the economy, then DO IT! Then he can blame the GOP & start minting zinc coins with his face on them.


He does, and he will...........................and guess what?,HE can blame who he wants, but the American conservative base,will know,IT WILL "ALL" BE ON THE BACK OF the younger voters/ minority groups/females and the usual suspects within the Progressive parties backs who re-elected his ass.


 They will not believe what is happening to them, even while it is taking place.



You voted for it, your gonna get it.

Wed, 11/28/2012 - 15:12 | 3018144 ServingMyKing
ServingMyKing's picture

No problem.  The 20% will be replaced by grateful immigrants.

Wed, 11/28/2012 - 18:10 | 3018664 real
real's picture

i must add this to the equation, the effect of diluting the labor pool from the bottom up to benefit the ruling class has meant that illegal immigrants have been allowed to enter the u.s. and these people know that if they start popping out babies they will get section 8, food stamps and money from the gov. They come here knowing this and pop out 2 or more kids just for the state money. The states know this and support this and why? it all comes down to the damn banksters/wall st of needing profit.

Wed, 11/28/2012 - 14:29 | 3017990 muppet_master
muppet_master's picture

SHORT FB @ $26.25

ADDED to my shorts from yesterday at $ AVG short price = $26....HOPEFULLY they can pump it to $28, $30 = my avg short price = $28....on MASSIVE SELL-OFFS willl sell DEEP in the $$$$ PUTS b4 dead cat bounces...after dead cat bounces collect massive $$$$ on puts....wash, rinse, repeat..until FB @ $5.00 = cover my original LONG TERM CAPITAL GAINS SHORTS on FB = enjoy life.

now gimme $28 and $30 flopbooks !!

Wed, 11/28/2012 - 14:37 | 3018008 Catullus
Catullus's picture

Good luck.

Wed, 11/28/2012 - 14:43 | 3018019 BlueCollaredOne
BlueCollaredOne's picture

Don't they have websites that cater to masturbating on a stage and why aren't you posting this there?

Wed, 11/28/2012 - 20:56 | 3019058 BraveSirRobin
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I am honestly not sure about that, but there is a cable network devoted to it. It's called C-SPAN.

Wed, 11/28/2012 - 15:04 | 3018102 edifice
edifice's picture

And I have a buy order in at $3. Who cares?

Wed, 11/28/2012 - 15:38 | 3018226 earnyermoney
earnyermoney's picture

I think the truck driver from Chicago found a new handle for Zero Hedge. Spalding Smailes or Johnny Bravo?

Wed, 11/28/2012 - 14:31 | 3017993 libertus
libertus's picture

USSA Bitches!

Wed, 11/28/2012 - 14:33 | 3017996 muppet_master
muppet_master's picture

boehner speaks

and he "boehner's" the shorts..LOL !! deja vu...same thing happened few weeks ago:

spx pumped from 1377 to 1390 previous tme he spoke...within 5 days it formed TEMP bottom @ 1343 ( i covered spx shorts @ 1360 AND went long @ 1360, 1354...RODE til 1402 black fri = and reloaded shorts).

this time will ride spx SHORTS til sub 1350 = enjoy life, not watch casino more than 15 minutes/day MAX.

Wed, 11/28/2012 - 14:51 | 3018036 muppet_master
muppet_master's picture

by the way..

the GOLD and EURO sell-offs haven't "recovered" = spx pump manipulation to 1406 high = will be crushing losses for the performance chasing widows and orphans...LOL !!!


Wed, 11/28/2012 - 14:34 | 3017997 Catullus
Catullus's picture

Agreed. Hence why ultra rich billionaires like Buffett keep volunteering the other non ultra "rich" high income earners higher tax rates. He knows he's squeezing out his competitors for political power.

And it's why 2008 was such bullshit. The ultra rich were in a position of forced liquidation. They were going to lose control of the really important stuff. That was only ever the point. Not the bonuses or the pay or the titles. Control was the only issue. None of the stuff that was illiquid was going to cease to exist. It was just on sale for dirt cheap. It was the chance to reshuffle the deck. But nope. Didn't happen. The rich kept control and they paid their political puppets well for doing so.

Wed, 11/28/2012 - 14:35 | 3018002 the not so migh...
the not so mighty maximiza's picture

thats pretty much it... Onward Ponzi-machinia

Wed, 11/28/2012 - 14:37 | 3018004 Tuco Benedicto ...
Tuco Benedicto Pacifico Juan Maria Ramirez's picture

Great entrepreneur eugenicist Buffett's companies received $90,000,000,000.00 in TARP money.  I saw him on CNBC this morning sans ice cream cone!  What's up with that!?



Wed, 11/28/2012 - 14:39 | 3018010 the not so migh...
the not so mighty maximiza's picture

I eat your ice cream and cone in front of you peasent

Wed, 11/28/2012 - 15:22 | 3018077 Joe Davola
Joe Davola's picture

As much as I hate the phrase "never waste a crisis", that's what was done in 2008.  If the Kenyan Crypto-Muslim had actually reformed the financial system we would be in a better place today, but I guess one would have to extract Soros' hand before seeing if Charley McCarthy can move his lips on his own.

Wed, 11/28/2012 - 16:47 | 3018419 blunderdog
blunderdog's picture

According to my calendar, Obama wasn't even ELECTED at the time of the '08 "crisis."

What was he supposed to have done?

Wed, 11/28/2012 - 21:16 | 3019102 nmewn
nmewn's picture

Accept Wall Street campaign contributions hand over fist?

Thu, 11/29/2012 - 10:38 | 3020273 blunderdog
blunderdog's picture

Maybe we just need the President to make massive changes to how the financial industry is regulated...

Wed, 11/28/2012 - 14:34 | 3017998 Tuco Benedicto ...
Tuco Benedicto Pacifico Juan Maria Ramirez's picture

"Green Shoots" "Fiscal Cliff" blah, blah, blah.  More crisis creating propaganda by the demonati!



Wed, 11/28/2012 - 14:58 | 3018065 BraveSirRobin
BraveSirRobin's picture

Fiscal Cliff is about: (1) Congressmen shaking down businessmen for more bribes (give me money and I will protect your interests); (2) creating a crisis so the government can add more power and control (to extort more money from more people); (3) reallocating federal expenditures to punish out-of-favor groups, and reward in-favor groups.

Wed, 11/28/2012 - 14:35 | 3018001 Grinder74
Grinder74's picture


Wed, 11/28/2012 - 14:40 | 3018013 Hayabusa
Hayabusa's picture

I just hate it whe people post and promote thier books here.  As far as my complacency being purchased by the elites, well that's the way capitalism works.  If you build a society based on $$ and profits, that is a logical consequence.

Wed, 11/28/2012 - 15:07 | 3018120's picture

A free market is not built by any one person or organization. That's the whole point.

Wed, 11/28/2012 - 15:22 | 3018177 Spastica Rex
Spastica Rex's picture

I think the point of the poster above is that there are specific undesireable (if unintended) consequences to our glorius, holy system. What the Invisible Hand wants, the Invisible Hand gets.

Wed, 11/28/2012 - 15:55 | 3018270's picture

He criticized capitalism which is not our system as evidence by the absence of the invisible hand. Few things are as counterproductive as complaining that the long forgotten cure is the thing that is currently killing you.

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